Oil AddictionDear Friends,
The External Costs of Petroleum Use
by Loren Cobb
In his 2006 State of the Union address, President Bush called for an end to the nation's "addiction to oil." These were remarkable words, coming from a man whose family fortune came from the petroleum industry. This, from a president who in the past has fought hard for additional subsidies and tax incentives for domestic oil exploration? This, from a president whose family and friends in the Texas oil business have profited enormously from the thick and complex web of hidden subsidies for petroleum in all its forms? One wonders why the change of heart, and whether he really has any inkling of what it will take.
Is Oil Really an Addiction?
Many countries of the world subsidize their energy industries, but the USA and several third world countries (Venezuela, Indonesia, Malaysia, and Bolivia, for example) stand out in this regard. These are the countries that subsidize gasoline, on the theory that lower gasoline prices will help domestic business and cause more rapid growth.
These subsidies have serious unintended consequences. According to the International Herald Tribune (9/27/05), subsidies have lowered the price of gasoline in Indonesia so much that the smuggling of cheap gasoline out of Indonesia for sale in other countries now costs the country $862 million annually. Similarly, so much subsidized Bolivian gasoline is smuggled into Peru that Bolivian cities often face outright shortages. Despite these clear problems, whenever the governments of these oil-subsidizing nations propose to reduce a subsidy on oil, they face tough political opposition.
All of this illustrates a point: When a government tries to reduce a subsidy, the pain felt by those affected the most can dominate the political discussion to such an extent that the effort is frequently abandoned even if the "greater good" would be served by eliminating the subsidy.
Physiological addiction has several points of similarity with this political problem. The physical symptoms of withdrawal from nicotine or an opiate like heroin or morphine are quite severe, and their immediate effects tend to drown out any abstract knowledge of what is best in the long run. This is why most addicts need the coordinated assistance of social institutions such as family, the courts, and rehab centers to complete the process of withdrawal successfully.
At least as a metaphor, then, the term "addiction" seems to apply quite well to subsidies for gasoline. But for gasoline itself, I think it does not apply. All physiological processes require energy to run, yet no one uses the word "addiction" to describe the dependence of physiology on energy. At best one might say that we are addicted to cheap gasoline but that is just another way of referring to hidden subsidies. So in the end, it all turns on one key question: What is the real cost of gasoline, and how does that differ from what we pay at the pump?
The "Real" Cost of Gasoline
At least ten independent attempts have been made that I know of to estimate a price for gasoline at the pump which corrects for all hidden subsidies, tax breaks, and external costs. The aggregated estimates for all hidden subsidies, tax breaks, and external costs in the USA fall into an astonishing range: from a low of nearly zero to a high of $1.7 trillion per year.
The differences between these estimates come from the joker in the deck: external costs, which are known in economics as "externalities." Whenever money changes hands, there are some costs and benefits in the transaction that are not reflected in the price paid. These are the externalities of the transaction.
Every time my car runs through a tank of gasoline, for example, there is an increment in local air pollution. This air pollution causes an increase in respiratory diseases (asthma, emphysema, pneumonia ...), and hastens some deaths in my community. Thus medical expenses in my community will increase by a small but measurable amount, there will be suffering and loss of income, and there will be loss of useful life. These are examples of "negative externalities" of my purchase of a tank of gasoline, because they are external to (i.e. not reflected within) the transaction itself. Positive externalities are also possible: these are external benefits.
Needless to say, estimating the size of these externalities is a matter of some difficulty and controversy. Being myself an asthmatic and highly sensitive to air pollution, I am nevertheless reminded every day that external costs are real and significant.
Let us set aside external costs such as health for a brief moment, and consider only direct subsidies and tax breaks. What would happen if Congress were to eliminate all direct subsidies and tax breaks for the petroleum industry? By my rough estimate, the pump price of gasoline in the USA would only rise by 5 to 50 cents per gallon. To my way of thinking, this is not enough to cause a significant change in driving behavior. We need to look more deeply, into the external costs of the use of petroleum.
The most extensive analysis of external costs in the price of gas is a report from the International Center for Technology Assessment the same people who came up with the $1.7 trillion annual estimate. Unfortunately, their analysis is riddled with questionable assumptions. To come to my own estimate, I reviewed the data and methods of a group of representative studies (the best are listed at the end of this letter).
My rough estimates of the top three external costs of petroleum use in the USA are (see the Notes Section below for details):
The total for this list is just a little more than the total sum now spent annually in the USA by consumers of gasoline (roughly $365 billion for 150 billion gallons of gasoline and diesel fuel). Taxes on gasoline and diesel fuel would have to increase to about $2.67 per gallon for consumers to experience via the prices at the pump anything even close to the "true" cost of gasoline.
As many of you will have noticed, I did not include in the total the present value of future increases in global warming due to today's petroleum use. The magnitude and duration of global warming effects are uncertain, and so is the time of onset, not to mention their exact nature. The entire topic is so complex, I had to set it aside in the interests of time.
If there is interest, I can dedicate a future essay to a discussion of how to think about (and estimate) the "expected present value" of phenomena (like global warming and nuclear energy) that have future effects which are large but uncertain. Despite the additional complexity, I think I can present the basic approach without indulging in an orgy of mathematics. Please let me know if you are interested, using our comment email address below.
Military costs of protecting energy supply and distribution could be included in the above list of external costs and some economists do exactly that but I omitted them because as long as we have a military, one of its many duties will be to protect energy supply and distribution, no matter whether it is in the form of oil or something else. The story is very different with health and global warming: these costs vary tremendously depending on the type of energy we use.
Though it has problems, using "addiction" as a metaphor for our habit of subsidizing petroleum-based fuels has some merit. Like any addict, to withdraw successfully from this behavior, the people of every gasoline-subsidizing nation will probably need the coordinated assistance of our most powerful social institutions, all working together.
Having now looked at the issue of present and future petroleum use in some detail, I am confident that the sharply rising price of gasoline, together with improving public appreciation of the cost of its monstrous externalities, will allow us to gradually overcome our "addiction" to cheap petroleum-based energy in the years to come even if gasoline taxes are not raised.
That day can be hastened in the USA, as it already has been in Europe and Japan, by eliminating subsidies for the petroleum industry, and by increasing fuel taxes to include more of total roadway costs and also some of the health costs of air pollution from fuel use. That step will of course be unpopular and painful, but then recovery from any addiction is a painful process.
Sincerely your friend,
(A grateful Thank you! to the Editorial Board of The Quaker Economist and the Louisville Writers Group for suggestions on improving this essay. Reminder: the opinions expressed here are only my own. LC)
Revised 12 Feb 2006, to mention military costs.
Two Methods for Estimating Health Externalities
Traditionally, the costs to a nation of illness and premature death due to environmental causes are estimated with the "damage function" (DF) method. In the case of petroleum, this takes at least four steps. First, estimate rates of environmental emissions (solid, liquid, gas). Second, calculate the exposure levels of the population. Third, relate exposure levels to increased rates of illness and death within each age group. Fourth, calculate the monetary value of these additional illnesses and early deaths, taking into account the age at which illness or death occurred. Needless to say, there are uncertainties at every stage of these calculations, and so the range of final estimates is typically very wide.
There is a complementary method which is strong where the DF method is weak, and vice versa. One can perform a "hedonic price analysis," (HPA), in which the statistical relationship between real estate prices and levels of pollution serves as an indicator of how much buyers will actually pay for lower exposure to pollution. If people are unaware of (or underestimate) the effects of pollution on their health, then the HPA method will give results that are substantially lower than the DF method. On the other hand, the HPA method has the great advantage of calculating social cost directly from objective data on how much people will actually pay for relief from pollution.
To my knowledge, there are no published overall DF and HPA estimates of the health cost of petroleum use. However, there is a 2002 article by Delucchi, Murphy, and McCubbin, which provides an important part of the answer. They constructed a "meta-HPA" based on many smaller studies, and compared it to their earlier DF estimate but only for air pollution. They did not analyze the smaller health effects of water- and soil-pollution from the use of petroleum.
The estimated range for the health cost of air pollution in the USA, using the DF method, was from $55 billion to $670 billion (1991 dollars) per year. Between 1991 and 2006, the overall rate of inflation as measured by the GDP deflator has been 33.8%. Thus in 2006 dollars, the estimated health cost of air pollution is thought to fall in a range from $74 billion to $896 billion. Because air pollution from petroleum use is a more important cause of health effects than water- or soil-pollution, and because medical care has increased in price at a rate three times that of inflation, I think it is reasonable to place the total health cost in a range from $100 billion to $1 trillion.
Delucchi points out (and I agree), that the true cost is likely somewhere in the lower half of the range, i.e. between $100 and $550 billion. For a point estimate, I use a round figure of $300 billion. The single greatest contribution to the uncertainty in this estimate comes from the monetary value of a premature death.
The meta-HPA method used by Delucchi's team produces lower results than the DF method, for several reasons. Their data for the relationship between real estate prices and air pollution came from surveys performed in 1980, when the American public was less informed about the health effects of air pollution, and more tolerant of air pollution than in the present era.
Despite this source of negative bias, the HPA estimates are still very important as an independent corroborative indicator. The estimated range for the health cost of air pollution in the USA, using the HPA method, was from $26.3 billion to $61.4 billion (1991 dollars) per year. Correcting as before for inflation, that corresponds to a range from $35 billion to $82 billion annually. This is considerably less than the $100 billion $1 trillion range of the DF method, but it serves as an important confirmation of the lower end of the DF estimate.
Method for Estimating Net Government Spending on Roadways
The ICTA's 1997 estimate for roadway construction and maintenance by governments at the federal, state, and local levels of the USA, net of gasoline taxes, tolls, and fees, came to $36$112 billion annually in 1997 dollars. In 2006 dollars that is roughly $42$131 billion, assuming 17% inflation over the period from 1997 to 2006. For a point estimate, I use the geometric mean of the two endpoints and round upwards. This gives a figure of $75 billion.
These are costs borne by all taxpayers not just drivers through government revenues other than fuel taxes, highway tolls, and registration fees.
There are many other direct subsidies in the ICTA list, but all together they total less than $2 billion, so I have ignored them.
Delucchi, Murphy, & McCubbin (2002), "The health and visibility cost of air pollution: A comparison of estimation methods." Journal of Environmental Management, vol 64, pp. 139152. Click here for the online edition.
ICTA (1998) "The Real Price of Gasoline," Report #3, International Center for Technology Assessment, 1998. Click here for ICTA's list of online publications, which includes the report and several updates. Caution: some of the assumptions in this study are extreme.
Koplow & Dernbach (2001) "Federal Fossil Fuel Subsidies and Greenhouse Gas Emissions," Annual Review of Energy and the Environment, vol. 26, pp. 361389. Click here for the online edition.
McCubbin & Delucchi (1996) The Social Cost of Health Effects of Motor Vehicle Air Pollution. UCD-ITS-RR-96-3(11). Davis, CA: Univ. of California, Institute of Transportation Studies. Click here for the online edition.
Sutherland (2001) " 'Big Oil' at the Public Trough: An Examination of Petroleum Subsidies." Policy Analysis, #390. The Cato Institute. Click here for the online edition. Caution: some of the assumptions in this study are extreme.
Please send comments on this or any TQE, at any time. Selected comments will be appended to the appropriate letter as they are received. Please indicate in the subject line the number of the Letter to which you refer!
Could you provide a breakdown on the forms of health externalities? $300 billion is about 15% of total U.S. health expenditures in 2005, and seems high. Europe uses a lot less petroleum per capita than the U.S., but I was not aware that morbidity and mortality are much lower in Europe.
In the late 80's, half the cars made in Brazil used alcohol, and in 1988 the cars I rented in Bahia and Rio ran on alcohol, but it took a big government subsidy and the program fell apart when not enough alcohol was produced. But I just read an article stating that in Brazil technological innovation has now greatly reduced the cost of sugar cane alcohol, and it is competitive at current gasoline prices, so Brazil once again is going the alcohol fuel route, although now with dual gasoline/alcohol motors.
William Rhodes, Germantown (PA) Friends Meeting.
A stimulating letter as always!
I would have thought that at least half our military expenditure (and the whole of the Iraq war) should be charged as an oil externality.
I suspect you under-rate the likely cost of global warming. To the extent that global warming is driven by rising atmospheric carbon dioxide (there is no doubt that atmospheric carbon dioxide has risen dramatically [from 316 ppm, parts per million, in 1959 to 377 ppm in 2004] ), and is increasing at an increasing rate. The problem is that at some unknown point, climate may change to a new equilibrium and those of us who survived, would have no way of getting back to where we are.
I know that there is the skeptical economist's position "don't incur costs until you are certain they are needed", as compared to the environmentalist's position "don't make environmental changes, until you are sure that they are safe." We are making environmental changes, and we certainly do not know that they are safe.
Thus I believe that your call to pay the full cost of petrol at the pump should be widened to paying the full cost of all fossil fuels (oil, coal and natural gas). Focusing on oil runs the danger of replacing petrol with coal generated electricity, to no climatic advantage.
Much of the global warming debate focuses on "stabilizing the rate of carbon emissions" but that would result in a steady rise in atmospheric carbon dioxide, with unpredictable results. To stabilize the (warmer) climate we need to achieve zero fossil carbon emissions. This will be expensive, so the sooner we start the better.
Wilfred Candler, Annapolis (MD) Friends Meeting.
It is a sad commentary when you review the definition of oil addiction and George Bush. George Bush is a hardened and ineffective politician. His type of government leadership is working hard to keep the status quo including wanting oil. It is unfortunate you bought into George Bush's addiction of oil by explaining it. Eliminating oil usage will come when the public finds the advantages through alternative energy. Norway, Sweden, France are working/seeking alternatives. George Bush? Status Quo.
Sam Di Muzio.
Loren, your opening reminded me of something I read: For Bush to berate Americans for being addicted to oil is like Dr. Kervorkian complaining that all his patients are dying!
A very nice piece of work on a subject I often mull myself! I very much like your detailed and logical approach it was very easy to follow and well referenced. However, I was astonished by your justification for not including military costs in the oil price. Yes, the military would be doing something else, but would an efficient economy not place the cost of the military where its services are demanded and used? Would this not encourage people to use resources that require less military support all other things being equal? And would it not provide a more natural means of decreasing the size of the military when its purpose is diminished?
Perhaps you were just being pragmatic in realizing any large decrease in military funding is not a change likely to happen quickly. Still, I would rather assume that we can change our nation's rather silly assumption that the military must exist en masse based upon the fact we earn income and live in a "free" country. If the military were to bill for its services like other businesses do (to those who demand and use them of course), I wonder whom they would charge.
I have seen many accountings of who supplies the military, but very few accountings of who uses the military. Trying to find who the military would really be charging were it to operate on a fee-for-service basis given its current activities would be a great economic analysis exercise!
Mark Powers, Minneapolis, MN.
Concerning the externalities you list that subsidize the oil addiction, you left out some massive ones, namely the huge military enforcement of keeping business as usual and oil flowing from the Mideast and SW Asia, South America, etc. Just this morning the newspaper announced that our our supplemental budget costs for the Iraq and Afghanistan wars alone have now reached about $400 billion total and the Iraq war is costing about $5.9 billion per month... Whoa!! That's a whopping omission of an externality. I contend that much of the military costs we all bear are truly a subsidy for maintaining the status quo of the petroleum economy. If the real costs of petrol fuel were seen, we wouldn't be buying trinkets and computers from China, cars from Japan, shoes from Vietnam, fruit from New Zealand, etc. Instead localized economies would be the reality.
So let us add your oil addiction externalities to mine:
Your subtotal = $400 billion/year.
Now add in the cost of US military enforcement of status quo oil flow:
My additional subtotal = $550 billion or thereabouts.
Other unquantified but real costs:
So when these externalities are added (not including my unquantified items) plus some of your costs adjusted upwards, the annual total could easily be greater than $1 trillion/year to prop up this oil addiction. Using your stated annual U.S. gasoline + diesel consumption of 150 billion gallons, that works out to a subsidy of about $6.67 per gallon. Using the higher number of $1.7 trillion you cited from International Center for Technology Assessment, the subsidy would be about $11.33 per gallon. And consumers complain with $60/bbl oil and the related $2+ per gallon of gas?
My conclusion: The American people are living in a dream world with the true costs of their oil addiction hidden from them, and much of it layed off on future generations, future devastation of the environment, future wars, or temporarily covered by our unreliable treasury notes held by other nations like China, Japan and the E.U.
Rich Andrews, Boulder (CO) Meeting.
The internalization of a negative externality may be desirable but are there no positive externalities? Thinking aloud, is freedom is perhaps one benefit? My family driving benefits them but also frees me. Many activities are viable only because people have transport. Without individual transport would we not need more public transport?
The impact on the environment is very difficult gasoline consumption by individuals is only a small fraction of energy use. Anyone of our Friends in the South in favor of living without AC? How about living without heat in New England? There is a reason that Canada outstrips even the US in energy use, and it isn't gasoline.
Stephen Baker, Columbus, OH.
I enjoyed this letter. "Submerged costs" are difficult to estimate, but you've done a reasonable job. I look forward to a future work on "expected present value for uncertain phenomena."
I wonder, however, about the effect opportunity costs have on externalities? As an example, If a truck moves fresh produce to market more quickly, so less spoilage occurs, how does this benefit enter into the equation? It seems my diet is better because of trucking (no Midwest orange groves), decreasing medical costs ever so slightly. If using gas is less costly than the cheapest alternative, should that matter in our cost estimates? Peace,
Jay Janney, Richmond First Friends, IN.
Should not some fraction of the military budget be incluuded in the cost of oil? One of the principal uses of the military is to keep the oil flowing and to keep the price low. I don't know how to calculate what fraction.
I think a discussion [of costs and benefits of a military] is long overdue, and I don't think one has to be a pacifist to wonder whether the cost is worth it. A non-pacifist could argue that we would need a much smaller military if it were not for the need to protect our access to oil in the Middle East (and perhaps in South America). One could then discuss whether there less expensive (and perhaps less futile) ways of achieving the same ends.
In fact part of the problem is that we regard all that oil as ours, going back to when the CIA helped the British overthrow Mossadegh's government in Iran for simply asking for a reasonable royalty.
Bruce Hawkins, Northampton Friends Meeting (NEYM).
Saddam didn't invade Kuwait because he was short of oil, but because he planned to corner the market. From there he would have threatened Saudi Arabia, giving him an ability to dictate world prices.
The dependence of the West on oil in particular is apparent when you consider the air-traffic use of it. Neither commercial nor military flying pays the true market costs of oil. The average price paid around the world for gasoline in cars is far greater than the price paid for aviation fuel. Fifty years from now, we will have had to reduce flying considerably, because we have no means other than oil of substantially doing it. We need to charge far more for this sooner rather than later.
Bush was clearly more interested in oil than anything else, but may have convinced himself that Democracy, (as he saw it) would deliver the oil into his hands peacefully.
Nick Bagnall, Claridge House Meeting, Quaker Healing Centre, Surrey, UK.
There is an interesting article by George Monbiot that was reprinted in The Guardian (click here for the original), arguing that "for the sake of the world's poor, we must keep the wealthy at home." While largely from a British point of view, this is of course relevant to the discussion of this letter, as well as to the promised future discussion of Global Warming.
A point which I have not previously seen mentioned is that under the 1944 Chicago Convention no government may levy tax on aviation fuel. Another is that the water vapour from burning aircraft fuel more than doubles the global warming effect of the carbon dioxide. Hydrogen-fuelled planes would therefore be even worse. Yet another point (relevant to the subject of addiction to oil) is the remarkably long design-life of our planes.
George Monbiot also states that new data suggest that carbon emissions for fast passenger ships and ultra-high-speed trains are comparable to those of planes.
I quote his last paragraph: "Flying kills. We all know it, and we all do it. And we won't stop doing it until the government reverses its policy and starts closing the runways."
Theo Tulley, Pickering and Hull MM, Hull PM.
How can war be "rationalized" in this day and age? And among Quakers? There as so many "costs" that you all left out: dead people, mutilated people, traumatized people, angry people, vengeful people, dis-spirited people ... and I'm talking about all sides. And, of course, there is the destruction to the land, animals, air and water. How do you "cost" those events?
I fully agree with the reply you gave about the reason for our wars. War is a physiological event and for the best analysis of this view I recommend James Hillman's The Terrible Love of War to you and your readers. A good analysis of his book may be found here. I think it should be required reading for all Friends.
Free Polazzo, Anneewakee Creek Worship Group, GA, and Atlanta Meeting, Atlanta, GA. [5 March 2006]
Found on the Web
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The Party's Over: Oil, War, and the Fate of Industrial Societies, by Richard Heinberg. New Society Publishers, 2003.
Copyright © 2006 by Loren Cobb. All rights reserved. Permission is hereby granted for non-commercial reproduction.